The Most Powerful People In Washington?

I bet if you asked 100 people in DC who the most powerful people in Washington are you’d get a variety of answers.  President Obama would probably top the list, but he wouldn’t be my first choice.  I’d say that Wendy Edelberg and Kim Kowalewski should get that honor. 

Who are Wendy and Kim and why would I chose them?  Wendy is the Asst. Director of Congressional Budget Office heading up their Macroeconomic Analysis Unit.  Kim is the Deputy Assistant Director managing the Macroeconomic Analysis Unit.  According to the CBO’s website, their unit is responsible for coming up with the economic assumptions used in the CBO’s baseline projections.

“The division’s projections serve as the economic assumptions for CBO’s baseline projections of the federal budget and help the budget committees develop their concurrent resolution on the budget. “  Source: CBO website

While seemingly insignificant, their work has a tremendous impact on our Nation.  Let’s just look at the values they came up with for one of the economic assumptions.  The assumption I’ve chosen to highlight is the inflation assumption (change in Consumer Price Increase – Urban (year to year).   Their unit came up with the following values for the next four years:

          2012 = 1.7%    2013 = 1.5%   2014 = 1.5%   2015 = 1.7%   2012 – 2015 Average = 1.6%

Inflation (change in CPI-U (Y to Y)) finished 2011 at 3.2%.   It has exceeded 3% five times beginning with 2000 and exceeded 2.5% in all but four years during that time period.  (The four years in which it didn’t exceed 2.5% were 2002 & 2003 (following 911) and 2009 & 2010 (following the financial collapse of 2008-09)).  If we look back at historic inflation we find the last time we had four successive years of  inflation below 2.0% was in the early 1960’s. 

Coming up with a reasonable answer to the question “How did they come up with such low inflation assumption values?” is pretty hard to do.  Coming up with a guess as to the answer to the question “Why did the come up with such low inflation assumption values?” is much easier.

The Obama Administration and the Democrats have a strategy that counts on the American Public believing that our financial crisis isn’t as bad as the tea party, conservatives and Republicans are making it out to be.  So what’s the best way to understate deficits and debt increases?  The best way to do that is to use understated inflation assumption values in the projections.  Understated inflation assumption values impact the budget projections, especially those for out years, in two ways.  The first is due to the principle of compounding.  Small values compound much slower than higher values.  The longer the period involved in the projections, the greater the impact.  The second is due to the fact that under “normal” circumstances, interest rates are tied to inflation.  This is especially true of short term interest rates.  So understating the inflation assumption values in the projections results in understated Interest Outlays, Deficits and Debt increase in the order of several trillions of dollars!

A test of the reasonableness of the inflation assumption values is a good way to see if there is any validity to my concerns.  Last year the CBO made a significant adjustment to their inflation assumption for 2011 during their Mid-Session Review.  They increased it to 2.9%, which still fell short of the 3.2% actual result for the year.  Despite under estimating the inflation rate for 2011, they chose an extremely low value of 1.7% for 2012.  After three months of 2012, CPI-U stood at 229.392.  If it remains at that level for the final nine months of 2012, inflation will finish the year at 1.815%, higher than their 1.7% projection.  But who in their “right” mind thinks we will have no more inflation the final nine months of the year?  Over the last two decades we’ve seen average inflation of 1.5% during the last nine months of a year.  It actually looks like this year we will exceed that.  CPI-U may just finish 2012 at the level they have projected it finishing at in 2013!

You can find a copy of the power point presentation that Director Elmendorf used during his talk to the National Economist Club earlier this year.  Page six includes a graph of historic and projected inflation.  If you follow the graph from the early 90’s on you see a series of peaks and valleys.  The question becomes, which is “standard” and which is “outlier” performance.  The valleys can easily be associated with “unusual events”.  The first (late 90’s) corresponds with the “Tech Stock Bubble Burst”, the second with “911”, the third with a major increase in the “Fed Fund Rate” that began in August, 2004 and the last corresponds with the aftermath of the financial collapse of 2008-09. 

Since the valleys can be so easily associated with unusual events (known as “outliers” in anlaysis talk), they would usually be excluded from modeling standard trends.  Excluding the valleys means the peaks become normal and represent the actual trend we’re experiencing.  But that means we’re experiencing increasing inflation, not historically low inflation.  And that means that the assumptions used in the CBO Baseline Projections are dramatically understated.  (If that’s the case it also brings into questions the values used by the WH OMB in their 2013 Budget Proposal too.)  And if the assumptions are dramatically understated then so are the Outlays, Deficits and the projected increase in the Debt!

Imagine if the 2012 Baseline projections showed an additional $5 trillion in deficits and debt.  Would the discussions in Washington be more reflective of those at tea party events?  Imagine if they showed an addition $10 trillion in deficits and debt.  Would the Obama Administration and Democrats be able to pretend that we really don’t have a crisis after all.

Now you know why I vote for Kim and Wendy as the most powerful people in Washington.  Their work has helped put the Country on the path to certain financial collapse by coming up with such unrealistic assumption values for inflation.  The only real question that remains is “Did they do this on purpose?”  The alternative is that Washington economists are so out of touch with reality that they actually thought they did a good job?

Reflect on the above and you’ll come up with your own conclusion on which is the case.  I’ve already come to mine!